Saturday, September 13, 2008

Is He a Liar, or Just Stupid?

I have long said that the housing correction poses the biggest risk to our economy. It is a drag on our economic growth, and at the heart of the turmoil and stress for our financial markets and financial institutions. Our economy and our markets will not recover until the bulk of this housing correction is behind us. Fannie Mae and Freddie Mac are critical to turning the corner on housing. Therefore, the primary mission of these enterprises now will be to proactively work to increase the availability of mortgage finance, including by examining the guaranty fee structure with an eye toward mortgage affordability.-- Jim Lockhard, Director of Federal Housing Finance Agency

Like the best of lies, this one has lots of truth in it. Broken down, here are the claims of the above paragraph.

Housing correction poses the biggest risk to our economy.

True

Our economy and our markets will not recover until the bulk of this housing correction is behind us.

True

Fannie and Freddie are critical to turning the corner on housing.

True -- they hold or guarantee about half of the US mortgages

Primary mission of Fannie and Freddie will be to increase the availability of mortgage finance.

False and stupid -- that's what got us into this mess in the first place.

The housing bubble was driven by the cheap availability of mortgages. Fannie and Freddie were key enablers of this by artificially inflating the secondary market for mortgages. This increased demand drove housing prices up for half a decade. Even after the recent 15-20% decrease, prices are still ~ 20% up over their long running positions relative to income or equivalent rental.

What makes housing affordable is the cost of the mortgage relative to income. Historically, house prices have tended to run at 3x annual income. At that rate, borrowers tended not to default and lenders made some profit. Whenever prices move too far from this multiple, they get corrected. The further the upswing, the more the correction hurts.

There is really only one way to keep the current housing prices from falling back to normal. Inflation. The boom was driven by asinine lending made profitable by being able to sell Mortgaged Backed Securities to banks and people who maybe should have known better but didn't. They know better now.

Now, the only way you're going to be able to sell a $500,000 house to someone making $100,000 is if they can be making $185,000 this time next year. That's going to take a whole heap of inflation in salaries without a corresponding inflation in home prices. Ain't gonna happen.

The only way out of the current housing mess is for prices to fall. That's going to hurt. The people that paid way too much for houses or Mortgage Backed Securities or companies dependent on consumer spending are all going to hurt.